FRB_ Speech, Bernanke — The Global Saving Glut and the U.S

8/3/2019 FRB_ Speech, Bernanke The Global Saving Glut and the U.S

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At the Sandridge Lecture, Virginia Association of Economists, Richmond, Virginia

Governor Bernanke presented similar remarks with updated data at the Homer Jones Lecture, St. Louis, Missouri, on April 14, 2005.

March 10, 2005

The Global Saving Glut and the U.S. Current Account Deficit

On most dimensions the U.S. economy appears to be performing well. Output growth hasreturned to healthy levels, the labor market is firming, and inflation appears to be wellcontrolled. However, one aspect of U.S. economic performance still evokes concern among

economists and policymakers: the nation's large and growing current account deficit. In thefirst three quarters of 2004, the U.S. external deficit stood at $635 billion at an annual rate,or about 5-1/2 percent of the U.S. gross domestic product (GDP). Corresponding to thatdeficit, U.S. citizens, businesses, and governments on net had to raise $635 billion oninternational capital markets. 1 The current account deficit has been on a steep upwardtrajectory in recent years, rising from a relatively modest $120 billion (1.5 percent of GDP)in 1996 to $414 billion (4.2 percent of GDP) in 2000 on its way to its current level. Mostforecasters expect the nation's current account imbalance to decline slowly at best, implyinga continued need for foreign credit and a concomitant decline in the U.S. net foreign assetposition.

Why is the United States, with the world's largest economy, borrowing heavily oninternational capital markets--rather than lending, as would seem more natural? Whatimplications do the U.S. current account deficit and our consequent reliance on foreigncredit have for economic performance in the United States and in our trading partners? Whatpolicies, if any, should be used to address this situation? In my remarks today I will offersome tentative answers to these questions. My answers will be somewhat unconventional inthat I will take issue with the common view that the recent deterioration in the U.S. currentaccount primarily reflects economic policies and other economic developments within theUnited States itself. Although domestic developments have certainly played a role, I willargue that a satisfying explanation of the recent upward climb of the U.S. current accountdeficit requires a global perspective that more fully takes into account events outside theUnited States. To be more specific, I will argue that over the past decade a combination of diverse forces has created a significant increase in the global supply of saving--a globalsaving glut--which helps to explain both the increase in the U.S. current account deficit andthe relatively low level of long-term real interest rates in the world today. The prospect of dramatic increases in the ratio of retirees to workers in a number of major industrialeconomies is one important reason for the high level of global saving. However, as I willdiscuss, a particularly interesting aspect of the global saving glut has been a remarkablereversal in the flows of credit to developing and emerging-market economies, a shift that hastransformed those economies from borrowers on international capital markets to large netlenders.

Speech, Bernanke The Global Saving Glut and the U.S. Current ... http://www.federalreserve.gov/boarddocs/speeches/2005/20050310

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To be clear, in locating the principal causes of the U.S. current account deficit outside thecountry's borders, I am not making a value judgment about the behavior of either U.S. orforeign residents or their governments. Rather, I believe that understanding the influence of global factors on the U.S. current account deficit is essential for understanding the effects of the deficit and for devising policies to address it. Of course, as always, the views I expresstoday are not necessarily shared by my colleagues at the Federal Reserve. 2

The U.S. Current Account Deficit: Two Perspectives

We will find it helpful to consider, as background for the analysis of the U.S. current accountdeficit, two alternative ways of thinking about the phenomenon--one that relates the deficitto the patterns of U.S. trade and a second that focuses on saving, investment, andinternational financial flows. Although these two ways of viewing the current account derivefrom accounting identities and thus are ultimately two sides of the same coin, each providesa useful lens for examining the issue.

The first perspective on the current account focuses on patterns of international trade. Youare probably aware that the United States has been experiencing a substantial trade

imbalance in recent years, with U.S. imports of goods and services from abroad outstrippingU.S. exports to other countries by a wide margin. According to preliminary data, in 2004 theUnited States imported $1.76 trillion worth of goods and services while exporting goods andservices valued at only $1.15 trillion. Reflecting this imbalance in trade, current paymentsfrom U.S. residents to foreigners (consisting primarily of our spending on imports, but alsoincluding certain other types of payments, such as remittances, interest, and dividends)greatly exceed the analogous payments that U.S. residents receive from abroad. Bydefinition, this excess of U.S. payments to foreigners over payments received in a givenperiod equals the U.S. current account deficit, which, as I have already noted, was on track to equal $635 billion in 2004--close to the $618 billion by which the value of U.S. importsexceeded that of exports.

When U.S. receipts from its sales of exports and other current payments are insufficient tocover the cost of U.S. imports and other payments to foreigners, U.S. households, firms, andgovernments on net must borrow the difference on international capital markets. 3 Thus,essentially by definition, in each period U.S. net foreign borrowing equals the U.S. currentaccount deficit, which in turn is closely linked to the imbalance in U.S. international trade.

That the nation's imports currently far exceed its exports is both widely understood and of concern to many Americans, particularly those whose livelihoods depend on the viability of exporting and import-competing industries. The extensive attention paid to the tradeimbalance in the media and elsewhere has tempted some observers to ascribe the growing

current account deficit to factors such as changes in the quality or composition of U.S. andforeign-made products, changes in trade policy, or unfair foreign competition. However, Ibelieve--and I suspect that most economists would agree--that specific trade-related factorscannot explain either the magnitude of the U.S. current account imbalance or its recent sharprise. Rather, the U.S. trade balance is the tail of the dog; for the most part, it has beenpassively determined by foreign and domestic incomes, asset prices, interest rates, andexchange rates, which are themselves the products of more fundamental driving forces.Instead, an alternative perspective on the current account appears likely to be more usefulfor explaining recent developments. This second perspective focuses on internationalfinancial flows and the basic fact that, within each country, saving and investment need not


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be equal in each period.

In the United States, as in all countries, economic growth requires investment in new capitalgoods and the upgrading and replacement of older capital. Examples of capital investmentinclude the construction of factories and office buildings and firms' acquisition of newequipment, ranging from drill presses to computers to airplanes. Residentialconstruction--the building of new homes and apartment buildings--is also counted as part of capital investment. 4

All investment in new capital goods must be financed in some manner. In a closed economywithout trade or international capital flows, the funding for investment would be providedentirely by the country's national saving. By definition, national saving is the sum of savingdone by households (for example, through contributions to employer-sponsored 401k accounts) and saving done by businesses (in the form of retained earnings) less any budgetdeficit run by the government (which is a use rather than a source of saving) 5.

As I say, in a closed economy investment would equal national saving in each period; but, infact, virtually all economies today are open economies, and well-developed internationalcapital markets allow savers to lend to those who wish to make capital investments in anycountry, not just their own. Because saving can cross international borders, a country'sdomestic investment in new capital and its domestic saving need not be equal in each period.If a country's saving exceeds its investment during a particular year, the differencerepresents excess saving that can be lent on international capital markets. By the sametoken, if a country's saving is less than the amount required to finance domestic investment,the country can close the gap by borrowing from abroad. In the United States, nationalsaving is currently quite low and falls considerably short of U.S. capital investment. Of necessity, this shortfall is made up by net foreign borrowing--essentially, by making use of foreigners' saving to finance part of domestic investment. We saw earlier that the currentaccount deficit equals the net amount that the United States borrows abroad in each period,and I have just shown that U.S. net foreign borrowing equals the excess of U.S. capitalinvestment over U.S. national saving. It follows that the country's current account deficitequals the excess of its investment over its saving.

To summarize, I have described two equivalent ways of interpreting the current accountdeficit, one in terms of trade flows and related payments and one in terms of investment andnational saving. In general, the perspective one takes depends on the particular analysis athand.

As I have already suggested, most economists who have offered explanations of the high andrising level of the U.S. current account deficit and the country's foreign borrowing haveemphasized investment-saving behavior rather than trade-related factors (and I will do thesame today). Along these lines, one commonly hears that the U.S. current account deficit isthe product of a precipitous decline in the U.S. national saving rate, which in recent yearshas fallen to a level that is far from adequate to fund domestic investment. For example, in1985 U.S. gross national saving was 18 percent of GDP, and in 1995 it was 16 percent of GDP; in 2004, by contrast, U.S. national saving was less than 14 percent of GDP. Those whoemphasize the role of low U.S. saving often go on to conclude that, for the most part, theU.S. current account deficit is "made in the U.S.A." and is independent (to a firstapproximation) of developments in other parts of the globe.

That inadequate U.S. national saving is the source of the current account deficit must be true


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at some level; indeed, the statement is almost a tautology. However, linking current-accountdevelopments to the decline in saving begs the question of why U.S. saving has declined. Inparticular, although the decline in U.S. saving may reflect changes in household behavior oreconomic policy in the United States, it may also be in some part a reaction to eventsexternal to the United States--a hypothesis that I will propose and defend momentarily.

One popular argument for the "made in the U.S.A." explanation of declining national savingand the rising current account deficit focuses on the burgeoning U.S. federal budget deficit,which in 2004 drained more than $400 billion from the national saving pool. I will discussthe link between the budget deficit and the current account deficit in more detail later. HereI simply note that the so-called twin-deficits hypothesis, that government budget deficitscause current account deficits, does not account for the fact that the U.S. external deficitexpanded by about $300 billion between 1996 and 2000, a period during which the federalbudget was in surplus and projected to remain so. Nor, for that matter, does the twin-deficitshypothesis shed any light on why a number of major countries, including Germany andJapan, continue to run large current account surpluses despite government budget deficitsthat are similar in size (as a share of GDP) to that of the United States. It seems unlikely,therefore, that changes in the U.S. government budget position can entirely explain thebehavior of the U.S. current account over the past decade.

The Changing Pattern of International Capital Flows and the Global Saving Glut

What then accounts for the rapid increase in the U.S. current account deficit? My ownpreferred explanation focuses on what I see as the emergence of a global saving glut in thepast eight to ten years. This saving glut is the result of a number of developments. As I willdiscuss in more detail later, one well-understood source of the saving glut is the strong savingmotive of rich countries with aging populations, which must make provision for animpending sharp increase in the number of retirees relative to the number of workers. Withslowly growing or declining workforces, as well as high capital-labor ratios, many advancedeconomies outside the United States also face an apparent dearth of domestic investment

opportunities. As a consequence of high desired saving and the low prospective returns todomestic investment, the mature industrial economies as a group seek to run current accountsurpluses and thus to lend abroad. 6

Although strong saving motives on the part of many industrial economies contribute to theglobal saving glut, the saving behavior of these countries does not explain much of theincrease in desired global saving in the past decade. Indeed, in a number of thesecountries--Japan is one example--household saving has declined recently. As we will see, apossibly more important source of the rise in the global supply of saving is the recentmetamorphosis of the developing world from a net user to a net supplier of funds tointernational capital markets.

Table 1 provides a basis for a discussion of recent changes in global saving and financialflows by showing current account balances for different countries and regions, in billions of U.S. dollars, for the years 1996 (just before the U.S. current account deficit began toballoon) and 2003 (the most recent year for which complete data are available). I shouldnote that these current account balances of necessity reflect realized patterns of investmentand saving rather than changes in the rates of investment and saving desired from an ex anteperspective. Nevertheless, changes in the pattern of current account balances together withknowledge of changes in real interest rates should provide useful clues about shifts in theglobal supply of and demand for saving.


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The table confirms the sharp increase in the U.S. current account deficit, about $410 billionbetween 1996 and 2003. (Data from the first three quarters of 2004 imply that the currentaccount deficit rose last year by an additional $140 billion at an annual rate.) In principle,the current account positions of the world's nations should sum to zero (although, in practice,data collection problems lead to a large statistical discrepancy, shown in the last row of table1). The $410 billion increase in the U.S. current account deficit between 1996 and 2003must therefore have been matched by a shift toward surplus of equal magnitude in othercountries. Which countries experienced this change?

As we can infer from table 1, most of the swing toward surplus did not occur in the otherindustrial countries as a whole (although some individual industrial countries did experiencelarge moves toward surplus, as we will see). The collective current account of the industrialcountries declined more than $388 billion between 1996 and 2003, implying that, of the$410 billion increase in the U.S. current account deficit, only about $22 billion was offset byincreased surpluses in other industrial countries. As table 1 shows, the bulk of the increase inthe U.S. current account deficit was balanced by changes in the current account positions of developing countries, which moved from a collective deficit of $88 billion to a surplus of $205 billion--a net change of $293 billion-- between 1996 and 2003. 7 The available datasuggest that the current accounts of developing and emerging-market economies swung afurther $60 billion into surplus in 2004.

This remarkable change in the current account balances of developing countries raises atleast three questions. First, what events or factors induced this change? Second, what causalrelationship (if any) exists between this change and current-account developments in theUnited States and in other industrial countries? Third, to the extent that the movementtoward surplus in developing-country current accounts has had a differential impact on theUnited States relative to other industrial countries, what accounts for the difference?

In my view, a key reason for the change in the current account positions of developing

countries is the series of financial crises those countries experienced in the past decade orso. In the mid-1990s, most developing countries were net importers of capital; as table 1shows, in 1996 emerging Asia and Latin America borrowed about $80 billion on net onworld capital markets. These capital inflows were not always productively used. In somecases, for example, developing-country governments borrowed to avoid necessary fiscalconsolidation; in other cases, opaque and poorly governed banking systems failed to allocatethose funds to the projects promising the highest returns. Loss of lender confidence, togetherwith other factors such as overvalued fixed exchange rates and debt that was bothshort-term and denominated in foreign currencies, ultimately culminated in painful financialcrises, including those in Mexico in 1994, in a number of East Asian countries in 1997-98, inRussia in 1998, in Brazil in 1999, and in Argentina in 2002. The effects of these crises

included rapid capital outflows, currency depreciation, sharp declines in domestic assetprices, weakened banking systems, and recession.

In response to these crises, emerging-market nations either chose or were forced into newstrategies for managing international capital flows. In general, these strategies involvedshifting from being net importers of financial capital to being net exporters, in some casesvery large net exporters. For example, in response to instability of capital flows and theexchange rate, some East Asian countries, such as Korea and Thailand, began to build uplarge quantities of foreign-exchange reserves and continued to do so even after theconstraints imposed by the halt to capital inflows from global financial markets were


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relaxed. Increases in foreign-exchange reserves necessarily involve a shift toward surplus inthe country's current account, increases in gross capital inflows, reductions in gross privatecapital outflows, or some combination of these elements. As table 1 shows, current accountsurpluses have been an important source of reserve accumulation in East Asia.

Countries in the region that had escaped the worst effects of the crisis but remainedconcerned about future crises, notably China, also built up reserves. These "war chests" of foreign reserves have been used as a buffer against potential capital outflows. Additionally,reserves were accumulated in the context of foreign exchange interventions intended topromote export-led growth by preventing exchange-rate appreciation. Countries typicallypursue export-led growth because domestic demand is thought to be insufficient to employfully domestic resources. Following the 1997-98 financial crisis, many of the East Asiancountries seeking to stimulate their exports had high domestic rates of saving and, relative tohistorical norms, depressed levels of domestic capital investment--also consistent, of course,with strengthened current accounts.

In practice, these countries increased reserves through the expedient of issuing debt to theircitizens, thereby mobilizing domestic saving, and then using the proceeds to buy U.S.Treasury securities and other assets. Effectively, governments have acted as financial

intermediaries, channeling domestic saving away from local uses and into internationalcapital markets. A related strategy has focused on reducing the burden of external debt byattempting to pay down those obligations, with the funds coming from a combination of reduced fiscal deficits and increased domestic debt issuance. Of necessity, this strategy alsopushed emerging-market economies toward current account surpluses. Again, the shifts incurrent accounts in East Asia and Latin America are evident in the data for the regions andfor individual countries shown in table 1.

Another factor that has contributed to the swing toward current-account surplus among thenon-industrialized nations in the past few years is the sharp rise in oil prices. The currentaccount surpluses of oil exporters, notably in the Middle East but also in countries such as

Russia, Nigeria, and Venezuela, have risen as oil revenues have surged. For example, as table1 shows, the collective current account surplus of the Middle East and Africa rose more than$40 billion between 1996 and 2003; it continued to swell in 2004 as oil prices increased yetfurther. In short, events since the mid-1990s have led to a large change in the collectivecurrent account position of the developing world, implying that many developing andemerging-market countries are now large net lenders rather than net borrowers oninternational financial markets.

Of course, developing countries as a group can increase their current account surpluses onlyif the industrial countries reduce their current accounts accordingly. How did this occur?Little evidence supports the view that the motivation to save has declined substantially in

the industrial countries in recent years; indeed, as I have noted already, demographic factorsshould lead the industrial countries to try to save more, not less. Instead, the requisite shift inthe collective external position of the industrial countries was facilitated by adjustments inasset prices and exchange rates, although the pattern of asset-price changes was somewhatdifferent before and after 2000.

From about 1996 to early 2000, equity prices played a key equilibrating role in internationalfinancial markets. The development and adoption of new technologies and risingproductivity in the United States--together with the country's long-standing advantages suchas low political risk, strong property rights, and a good regulatory environment--made theU.S. economy exceptionally attractive to international investors during that period.


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Consequently, capital flowed rapidly into the United States, helping to fuel largeappreciations in stock prices and in the value of the dollar. Stock indexes rose in otherindustrial countries as well, although stock-market capitalization per capita is significantlylower in those countries than in the United States.

The current account positions of the industrial countries adjusted endogenously to thesechanges in financial market conditions. I will focus here on the case of the United States,which bore the bulk of the adjustment. From the trade perspective, higher stock-marketwealth increased the willingness of U.S. consumers to spend on goods and services, includinglarge quantities of imports, while the strong dollar made U.S. imports cheap (in terms of dollars) and exports expensive (in terms of foreign currencies), creating a rising tradeimbalance. From the saving-investment perspective, the U.S. current account deficit rose ascapital investment increased (spurred by perceived profit opportunities) at the same timethat the rapid increase in household wealth and expectations of future income gains reducedU.S. residents' perceived need to save. Thus the rapid increase in the U.S. current accountdeficit between 1996 and 2000 was fueled to a significant extent both by increased globalsaving and the greater interest on the part of foreigners in investing in the United States.

After the stock-market decline that began in March 2000, new capital investment and thus

the demand for financing waned around the world. Yet desired global saving remainedstrong. The textbook analysis suggests that, with desired saving outstripping desiredinvestment, the real rate of interest should fall to equilibrate the market for global saving.Indeed, real interest rates have been relatively low in recent years, not only in the UnitedStates but also abroad. From a narrow U.S. perspective, these low long-term rates arepuzzling; from a global perspective, they may be less so. 8

The weakening of new capital investment after the drop in equity prices did not muchchange the net effect of the global saving glut on the U.S. current account. The transmissionmechanism changed, however, as low real interest rates rather than high stock prices becamea principal cause of lower U.S. saving. In particular, during the past few years, the keyasset-price effects of the global saving glut appear to have occurred in the market forresidential investment, as low mortgage rates have supported record levels of homeconstruction and strong gains in housing prices. Indeed, increases in home values, togetherwith a stock-market recovery that began in 2003, have recently returned the wealth-to-income ratio of U.S. households to 5.4, not far from its peak value of 6.2 in 1999 andabove its long-run (1960-2003) average of 4.8. The expansion of U.S. housing wealth, muchof it easily accessible to households through cash-out refinancing and home equity lines of credit, has kept the U.S. national saving rate low--and indeed, together with the significantworsening of the federal budget outlook, helped to drive it lower. As U.S. businessinvestment has recently begun a cyclical recovery while residential investment has remainedstrong, the domestic saving shortfall has continued to widen, implying a rise in the currentaccount deficit and increasing dependence of the United States on capital inflows. 9

According to the story I have sketched thus far, events outside U.S. borders--such as thefinancial crises that induced emerging-market countries to switch from being internationalborrowers to international lenders--have played an important role in the evolution of the U.S.current account deficit, with transmission occurring primarily through endogenous changesin equity values, house prices, real interest rates, and the exchange value of the dollar. Onemight ask why the current-account effects of the increase in desired global saving were feltdisproportionately in the United States relative to other industrial countries. Theattractiveness of the United States as an investment destination during the technology boom


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of the 1990s and the depth and sophistication of the country's financial markets (which,among other things, have allowed households easy access to housing wealth) have certainlybeen important. Another factor is the special international status of the U.S. dollar. Becausethe dollar is the leading international reserve currency, and because some emerging-marketcountries use the dollar as a reference point when managing the values of their owncurrencies, the saving flowing out of the developing world has been directed relatively moreinto dollar-denominated assets, such as U.S. Treasury securities. The effects of the savingoutflow may thus have been felt disproportionately on U.S. interest rates and the dollar. Forexample, the dollar probably strengthened more in the latter 1990s than it would have if ithad not been the principal reserve currency, enhancing the effect on the U.S. currentaccount.

Most interesting, however, is that the experience of the United States in recent years is notso nearly unique among industrial countries as one might think initially. As shown in table 1,a number of key industrial countries other than the United States have seen their currentaccounts move substantially toward deficit since 1996, including France, Italy, Spain,Australia, and the United Kingdom. The principal exceptions to this trend among the majorindustrial countries are Germany and Japan, both of which saw substantial increases in theircurrent account balances between 1996 and 2003 (and significant further increases in 2004).A key difference between the two groups of countries is that the countries whose currentaccounts have moved toward deficit have generally experienced substantial housingappreciation and increases in household wealth, while Germany and Japan--whoseeconomies have been growing slowly despite very low interest rates--have not. For example,wealth-to-income ratios have risen since 1996 by 14 percent in France, 12 percent in Italy,and 27 percent in the United Kingdom; each of these countries has seen their currentaccount move toward deficit, as already noted. By contrast, wealth-to-income ratios inGermany and Japan have remained flat. 10 The evident link between rising household wealthand a tendency for the current account to shift toward deficit is consistent with themechanism that I have described today.

Economic and Policy Implications

I have presented today a somewhat unconventional explanation of the high and rising U.S.current account deficit. That explanation holds that one of the factors driving recentdevelopments in the U.S. current account has been the very substantial shift in the currentaccounts of developing and emerging-market nations, a shift that has transformed thesecountries from net borrowers on international capital markets to large net lenders. This shiftby developing nations, together with the high saving propensities of Germany, Japan, andsome other major industrial nations, has resulted in a global saving glut. This increasedsupply of saving boosted U.S. equity values during the period of the stock market boom andhelped to increase U.S. home values during the more recent period, as a consequencelowering U.S. national saving and contributing to the nation's rising current account deficit.

From a global perspective, are these developments economically beneficial or harmful?Certainly they have had some benefits. Most obviously, the developing and emerging-marketcountries that brought their current accounts into surplus did so to reduce their foreign debts,stabilize their currencies, and reduce the risk of financial crisis. Most countries have beenlargely successful in meeting each of these objectives. Thus, the shift of these economiesfrom borrower to lender status has provided at least a short-term palliative for some of theproblems they faced in the 1990s.


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In the longer term, however, the current pattern of international capital flows--should itpersist--could prove counterproductive. Most important, for the developing world to belending large sums on net to the mature industrial economies is quite undesirable as along-run proposition. Relative to their counterparts in the developing world, workers inindustrial countries have large quantities of high-quality capital with which to work.Moreover, as I have already noted, the populations of most of these countries are bothgrowing slowly and aging rapidly, implying that ratios of retirees to workers will rise sharplyin coming decades. For example, in the United States, for every 100 people between the agesof 20 and 64, there are currently about 21 people aged 65 or older. According to UnitedNations projections, by 2030 the population of the United States will include about 34people aged 65 or over for each 100 people in the 20-64 age range; for the Euro area andJapan, the analogous numbers in 2030 will be 46 and 57, respectively. Over the remainder of the century, the populations of other major industrial countries will age much more quicklythan that of the United States. In 2050, for example, the number of retirees for each 100working-age people in the United States should be about the same as in 2030, about 34, butthe number of retirees per 100 working-age people is projected to increase to about 60 in theEuro area and about 78 in Japan.

We see that many of the major industrial countries--particularly Japan and some countries inWestern Europe--have both strong reasons to save (to help support future retirees) andincreasingly limited investment opportunities at home (because workforces are shrinking andcapital-labor ratios are already high). In contrast, most developing countries have youngerand more-rapidly growing workforces, as well as relatively low ratios of capital to labor,conditions that imply that the returns to capital in those countries may potentially be quitehigh.11 Basic economic logic thus suggests that, in the longer term, the industrial countries asa group should be running current account surpluses and lending on net to the developingworld, not the other way around. If financial capital were to flow in this "natural" direction,savers in the industrial countries would potentially earn higher returns and enjoy increaseddiversification, and borrowers in the developing world would have the funds to make thecapital investments needed to promote growth and higher living standards. Of course, toensure that capital flows to developing countries yield these benefits, the developingcountries would need to make further progress toward improving conditions for investment,as I will discuss further in a bit.

A second issue concerns the uses of international credit in the United States and otherindustrial countries with external deficits. Because investment by businesses in equipmentand structures has been relatively low in recent years (for cyclical and other reasons) andbecause the tax and financial systems in the United States and many other countries aredesigned to promote homeownership, much of the recent capital inflow into the developedworld has shown up in higher rates of home construction and in higher home prices. Higherhome prices in turn have encouraged households to increase their consumption. Of course,increased rates of homeownership and household consumption are both good things.However, in the long run, productivity gains are more likely to be driven by nonresidentialinvestment, such as business purchases of new machines. The greater the extent to whichcapital inflows act to augment residential construction and especially current consumptionspending, the greater the future economic burden of repaying the foreign debt is likely to be.

A third concern with the pattern of capital flows arises from the indirect effects of thoseflows on the sectoral composition of the economies that receive them. In the United States,for example, the growth in export-oriented sectors such as manufacturing has been


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restrained by the U.S. trade imbalance (although the recent decline in the dollar hasalleviated that pressure somewhat), while sectors producing nontraded goods and services,such as home construction, have grown rapidly. To repay foreign creditors, as it mustsomeday, the United States will need large and healthy export industries. The relativeshrinkage in those industries in the presence of current account deficits--a shrinkage thatmay well have to be reversed in the future--imposes real costs of adjustment on firms andworkers in those industries.

Finally, the large current account deficit of the United States, in particular, requiressubstantial flows of foreign financing. As I have discussed today, the underlying sources of the U.S. current account deficit appear to be medium-term or even long-term in nature,suggesting that the situation will eventually begin to improve, although a return toapproximate balance may take some time. Fundamentally, I see no reason why the wholeprocess should not proceed smoothly. However, the risk of a disorderly adjustment infinancial markets always exists, and the appropriately conservative approach forpolicymakers is to be on guard for any such developments.

What policy options exist to deal with the U.S. current account deficit? I have downplayedthe role of the U.S. federal budget deficit today, and I disagree with the view, sometimes

heard, that balancing the federal budget by itself would largely defuse the current accountissue. In particular, to the extent that a reduction in the federal budget resulted in lowerinterest rates, the principal effects might be increased consumption and investment spendingat home rather than a lower current account deficit. Indeed, a recent study suggests that aone-dollar reduction in the federal budget deficit would cause the current account deficit todecline less than 20 cents (Erceg, Guerrieri, and Gust, 2005). These results imply that even if we could balance the federal budget tomorrow, the medium-term effect would likely be toreduce the current account deficit by less than one percentage point of GDP.

Although I do not believe that plausible near-term changes in the federal budget wouldeliminate the current account deficit, I should stress that reducing the federal budget deficit

is still a good idea. Although the effects on the current account of reining in the budgetdeficit would likely be relatively modest, at least the direction is right. Moreover, there areother good reasons to bring down the federal budget deficit, including the reduction of thedebt obligations that will have to be serviced by taxpayers in the future. Similar observationsapply to policy recommendations to increase household saving in the United States, forexample by creating tax-favored saving vehicles. Although the effect of saving-friendlypolicies on the U.S. current account deficit might not be dramatic, again the direction wouldbe right. Moreover, increasing U.S. national saving from its current low level would supportproductivity and wealth creation and help our society make better provision for the future.

However, as I have argued today, some of the key reasons for the large U.S. current account

deficit are external to the United States, implying that purely inward-looking policies areunlikely to resolve this issue. Thus a more direct approach is to help and encouragedeveloping countries to re-enter international capital markets in their more natural role asborrowers, rather than as lenders. For example, developing countries could improve theirinvestment climates by continuing to increase macroeconomic stability, strengthen propertyrights, reduce corruption, and remove barriers to the free flow of financial capital. Providingassistance to developing countries in strengthening their financial institutions--for example,by improving bank regulation and supervision and by increasing financialtransparency--could lessen the risk of financial crises and thus increase both the willingnessof those countries to accept capital inflows and the willingness of foreigners to invest there.


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Financial liberalization is a particularly attractive option, as it would help both to permitcapital inflows to find the highest-return uses and, by easing borrowing constraints, to spurdomestic consumption. Other changes will occur naturally over time. For example, the paceat which emerging-market countries are accumulating international reserves should slow asthey increasingly perceive their reserves to be adequate and as they move toward moreflexible exchange rates. The factors underlying the U.S. current account deficit are likely tounwind only gradually, however. Thus, we probably have little choice except to be patient aswe work to create the conditions in which a greater share of global saving can be redirectedaway from the United States and toward the rest of the world--particularly the developingnations.

Footnotes

1. As U.S. capital outflows in those three quarters totaled $728 billion at an annual rate,gross financing needs exceeded $1.3 trillion. Return to text

2. I thank David Bowman , Joseph Gagnon , Linda Kole, and Maria Perozek of the Boardstaff for excellent assistance. Return to text

3. For simplicity, I will use the term "net foreign borrowing" to refer to the financing of thecurrent account deficit, though strictly speaking this financing involves the sale of foreignand domestic assets as well as the issuance of debt securities to foreigners. As illustrated bythe data in footnote 1, U.S. gross foreign borrowing is much larger than net foreignborrowing, as gross borrowing must be sufficient to offset not only the deficit in currentpayments but also U.S. capital outflows. Return to text

4. This definition of capital investment ignores many less tangible forms of investment, suchas research and development expenditures. It also ignores investment in human capital, suchas educational expenses. Using a more inclusive definition of investment could well changeour perceptions of U.S. saving and investment trends quite substantially. I will leave thattopic for another day. Return to text

5. The Bureau of Economic Analysis treats government investment--in roads or schools, forinstance--as part of national saving in the national income accounts. Thus, strictly speaking,national saving is reduced by the government deficit net of government investment, not bythe entire government deficit. The difference between domestic investment and nationalsaving is not affected by this qualification, however, as government investment and theimplied adjustment to national saving cancel each other out. Return to text

6. By "high desired saving" I mean a supply schedule for saving that is shifted far to theright. Actual or realized saving depends on the equilibrium values of the real interest rate

and other economic variables. Return to text

7. The statistical discrepancy also increased substantially, by $96 billion on net. As assetaccumulation in developing countries may be less completely measured than in industrialcountries, a significant part of the change in the discrepancy may represent an additionalmovement toward surplus in developing-country current accounts. Return to text

8. In pointing out the possible effects of strong global saving on real interest rates, I do notmean to rule out other factors. For example, a lowering of risk premiums resulting fromincreased macroeconomic and monetary stability has likely played some role. Return to text


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9. Greenspan (2005) notes a strong correlation between U.S. mortgage debt and the U.S.current account deficit. Return to text

10. These data are from Annex Table 58, OECD Economic Outlook, vol. 76, 2004, p. 226.The latest year for which data are available is 2003 for Germany and the United Kingdom,2002 for France, Italy, and Japan. Return to text

11. China is an important exception to the generalization that developing countries haveyoung populations. The country's fertility rate has declined since the 1970s, and its elderlydependency ratio is expected to exceed that of the United States by midcentury. Return totext

References

Erceg, Christopher, Luca Guerrieri, and Christopher Gust (2005). "Expansionary FiscalShocks and the Trade Deficit." International Finance Discussion Paper 2005-825.Washington: Board of Governors of the Federal Reserve System (January).

Greenspan, Alan (2005). "Current account." Speech at Advancing Enterprise 2005Conference, London, February 4.

Table 1. Global Current Account Balances, 1996 and 2003 (Billions of U.S. dollars)Countries 1996 2003

Industrial 46.2 -342.3

United States -120.2 -530.7

Japan 65.4 138.2

Euro Area 88.5 24.9

France 20.8 4.5

Germany -13.4 55.1

Italy 39.6 -20.7

Spain 0.4 -23.6

Other 12.5 25.3

Australia -15.8 -30.4Canada 3.4 17.1

Switzerland 21.3 42.2

United Kingdom -10.9 -30.5

Developing -87.5 205.0

Asia -40.8 148.3

China 7.2 45.9


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Hong Kong -2.6 17.0

Korea -23.1 11.9

Taiwan 10.9 29.3

Thailand -14.4 8.0

Latin America -39.1 3.8

Argentina -6.8 7.4

Brazil -23.2 4.0

Mexico -2.5 -8.7

Middle East and Africa 5.9 47.8

E. Europe and the former Soviet Union -13.5 5.1

Statistical discrepancy 41.3 137.2Return to text

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FRB_ Speech, Bernanke — The Global Saving Glut and the U.S